The Business of Ground Zero

A half-century ago, the imperious Port Authority director Austin Tobin unveiled a plan for the public agency to build two gigantic towers on the western edge of a struggling Lower Manhattan, creating a new office district, a city within a city, of 9 million square feet.

Built in the early 1970s, the World Trade Center towers proved a tremendous drain, only starting to provide enough money to cover debt service in the 1980s and not widely viewed as a stable money-maker until the 1990s. The $1 billion project was more than double earlier estimates; it was financed with tax-free debt backed by the public sector. New York State was by far the largest tenant, taking a full 2 million square feet to help fill what would have otherwise been empty floors.

For years, this was a cautionary tale in real estate. The property may ultimately have proved successful, yet only after decades of coddling and support by a public sector.

But history finds a way of repeating itself.

The public sector is now on the verge of putting itself in a position to relive the very financial pain it endured a generation ago.

A yearlong battle over the World Trade Center site between private developer Larry Silverstein, the Port Authority and the city seems to be ending, with all three parties converging on a plan to use the financial backing of various public-sector sources to help finance two of the three skyscrapers Mr. Silverstein had planned.While the details are still under discussion and talks could yet break down, it would put hundreds of millions, if not billions, of additional public dollars at risk, as some combination of the Port Authority, the city and the state would likely back the financing on the bulk of the $4 billion–plus cost of the two privately built towers. Mr. Silverstein would be required to use hundreds of millions in insurance money and additional capital.

Taken with the $3.1 billion, Port Authority–owned One World Trade Center (formerly the Freedom Tower) currently rising, the Silverstein deal, should it indeed mature, would mean nearly 7 million square feet, or two and a half Empire State Buildings, constructed within the span of a few years on one site—all with only a single private tenant in place, China-based Beijing Vantone, for a relatively trivial 190,000 square feet, or six floors.

This comes on top of prior pacts in which the federal, state and city governments agreed to numerous other incentives, including agreeing to lease more then 2 million square feet at the site and offering more than $2 billion in tax-free bonds to bring financing costs down.

The path to this point—to be on the verge of additional public subsidy of two World Trade Center towers—was a tortuous and hard-fought one, and backers of the Silverstein deal-in-progress insist that an overly complex design for the site and a financial structure carved during the boom make the government bailout the best of many bad options.

But questions of rationale aside, the total financial risk to the public at the site as a whole, particularly in the government-owned One World Trade Center, is tremendous. A recovery could lag, the recession could linger; tenants could eschew Lower Manhattan or the new Silverstein towers, as at least two banks—Goldman Sachs and JPMorgan Chase—have, thereby leading to a default. (The bulk of any loss would fall on the Port Authority and would likely crimp transportation spending.)

This, of course, is not how office towers typically get built. Developers, particularly in a recession, traditionally must have a large private tenant in hand to get anything but a laugh from lenders, and speculative office space very rarely flies on such a large scale.

This has sparked concerns that the office towers could be slow to lease up, potentially languishing for years without enough rent to even cover the mortgage payments. “Just building office buildings doesn’t mean you’re creating jobs,” said Barry Gosin, CEO of brokerage Newmark Knight Frank. “It’s not like the field of dreams. We’ve learned that lesson before.”

This is particularly a worrisome concept in Lower Manhattan. Dark clouds are gathering over the neighborhood, as it is expected to soon see a tremendous amount of office space go vacant, with no clear answer as to who will fill it. Brokerage Jones Lang LaSalle has projected downtown vacancy rates will soar to more than 20 percent by 2014, led by major financial firms with expiring leases that cover more than 7 million square feet.

Public criticism of the trade center plan is, somewhat curiously, muted, restricted to a handful of advocacy groups. This was not the case in the 1960s. Fearing a glut of space, the real estate industry at the time, led by landlords Seymour Durst and Lawrence Wien, was incensed by the Port Authority’s plan to build the 9 million–square–foot twin towers and rallied to try to stop it with public criticism and legal action.